Readers who have been following my short-term hedge positions against the Hawking portfolio will know that I have positions expiring today (Quarterly Options in SPX). I also still have on an “Iron Condor” Hedge, expiring on Friday:

This is a wide “Condor” position and is (almost certainly) likely to expire with a $500 profit. However, I have chosen to spend this money (and a little more) to boost potential profits a little higher. I’ve added a standard “Put Condor” such that the total position now looks as follows:

The Put Condor was purchased for $1,700 (5 x 3.40 x 100) with the SPX trading at ~ 1983 and maximum profit potential on the total positions is now $6,300 with SPX closing between 1965 and 1975 at expiration on Friday. Maximum (likely) loss is $1200 (5:1 Reward/Risk) with SPX below 1950 or above 1990 at expiration. Larger losses are possible (max $3,700) but that would need moves of greater than 2 Standard deviations either up or down.

At 1:00 pm the positions expiring today are looking good for a nice profit (max $3,150 with SPX closing between 1960 and 1985) – so I’m hoping for a good finish to the week to offset most of my earlier losses on my Option hedges.

I realize this is “trading” rather than investing – and maybe not totally relevant to this site – but I know a few members have an interest.

The main message I’d like to convey is that Options are not necessarily risky provided we understand our risk and are comfortable with it. In the above examples I know exactly what my maximum risk and maximum rewards are, together with an idea of the statistical probabilities of making/losing money.

David

William Tynes says

Hi David,

Can you please explain how the option exercise actually works at the close. Do you actually have to exercise the option before the close or does the option expire “in the money.”

HedgeHunter says

William,

Good question (and a little complicated when it comes to SPX), so I’ll try to keep the answer as short as possible.

First, specific to SPX (and most Index) Options,

1) All In-The-Money (ITM) Options are Cash-Settled – therefore really no margin requirements to worry about;

2) For Weekly and Quarterly Options the Settlement Price is the End-of-Day (PM) closing price of the SPX on the expiry date;

3) For “Standard” SPX Monthly Options (expiring on the 3rd Friday of the Month), the Settlement Price (Ticker SET) is calculated as the price of the SPX as determined by the (AM) opening price of each S&P component asset. This usually takes ~1-2 hours after the open to determine, since not all components of the index trade at the open. A consequence of this style of settlement is that, since the Options cannot be traded on the expiration date (Friday) and the Settlement Price (SET) can be either higher or lower than the Thursday SPX closing price, there is uncontrollable risk (and possibly sleepless night ðŸ™‚ ) associated with holding “Standard” SPX Options into expiration. If I am holding “Standard” SPX Options that are close to the At-the-Money (ATM) strike I will generally close out the position before the Thursday close.

4) To avert the problems of 3), there are end-of-day settlement options available – Ticker SPXPM.

The above are specific to SPX (and other European-Style Index Options) but all Stock and ETF Options are equity-settled i.e. the Option is closed, if ITM at expiration, and exercised or assigned resulting in the purchase or sale of the underlying asset. Obviously you will need to have sufficient funds (margin) in your account to cover these transactions – your broker will be sure to let you know if you don’t have the funds ðŸ™‚ . Officially, the expiration date for equity/ETF options is a Saturday with the Friday end-of-day price determining the asset value/price. Of course, you can always close out the options, prior to expiration, by buying or selling to close the position.

Hope this answers your question reasonably clearly – otherwise ask for clarifications.

David